The global gaze has been firmly trained on Glasgow over recent weeks, with celebrities, world leaders and everyone in between descending on the city for the COP26 event on climate change.
Headline-grabbing announcements included over 100 countries pledging to cut methane emissions by 30% and a goal to halt deforestation, both by 2030, as well as UK Chancellor Rishi Sunak unveiling a mandate for large companies to develop net zero transition plans by 2024. We also saw a joint deal on emissions between the US and China and a Global Coal to Clean Power Transition Statement signed by more than 190 parties, committing to phase out coal from major economies by 2030 and by 2040 for the rest of the world. Both are seen as key to COP 26’s mantra of ‘keeping the 1.5 degrees alive’.
This goal to limit global average temperature rises, compared to industrial levels, to less than 2 degrees centigrade, and ideally less than 1.5, was approved in the Paris Agreement, adopted at COP21 in December 2015 and implemented a year later. But the seminal Intergovernmental Panel on Climate Change (IPCC) report, published in October 2018, still shocked many with its stark conclusion: to meet that 1.5 degree target and stand any chance of keeping climate change manageable, we need to halve absolute emissions by 2030 or sooner.
Whatever ultimately comes from the developments at COP26, we will continue to see huge disruption as the world grapples with the energy transition. All actors in the economy, whether governments, companies or individuals, need to halve emissions and we cannot stand back waiting for others to take the lead.
Such a reduction will impact the whole economy, including our energy system and how we heat and cool buildings but also driving transformations in transport, industrial processes, agriculture and land use. This move to an ultra-low carbon economy will also have an impact on investment returns: companies contributing to this shift should prosper while those on the wrong side of the energy transition, or not confronting its ramifications, are at risk of secular decline.
To stay on the right side in our Sustainable Future funds, we have always avoided areas such as fossil fuel extraction and production and, more broadly, internal combustion engine car manufacturers, airlines and energy-intensive businesses not positioning for a lower-carbon world. In terms of more positive themes, our funds, on average, have 28% invested in companies improving resource efficiency and reducing emissions across areas such as energy waste, smarter water management and increasing recycled material. The funds emit 68% less (in terms of companies held) than the markets in which they invest and our stocks have less carbon costs to pass on to customers, meaning their margins will be more resilient to inevitably tightening emission regulations.
As part of our ongoing engagement with companies, we are also challenging those held across the funds to be more ambitious in terms of decarbonisation targets. We launched our 1.5 Degree Transition Challenge last year, recognising the pace of change was falling well short of the level demanded: incremental annual targets of 1%-2% will take decades to halve emissions when science is telling us this needs to happen in less than 10.
Based on our work so far, around a quarter of companies with which we engaged have absolute decarbonisation targets consistent with 1.5 degrees and a further 9% have committed to 2 degrees, which means a third overall are aligned with the Paris Agreement. This obviously means two-thirds do not, at present, have targets in line with the science but this is moving quickly, with many demonstrating positive momentum. The biggest challenge lies in fast-growing companies, where carbon intensity targets have to be significantly higher than how much the business is growing for there to be any fall in absolute emissions. If a business is growing 5% a year and the target to reduce carbon intensity (per unit of sales) is 2%, absolute emissions are still rising by 3% annually.
Responding in a timely manner to the climate crisis is important but we have to bear in mind climate change also has a social dimension. Many people work in industries facing formidable change and must be able to afford to live a fulfilled life in an ultra-low carbon economy. We must remember not to solve only for the best climate change outcome but ensure we also use this as an opportunity to reduce inequality, help alleviate fuel poverty and not lose sight of people. If people do not willingly move with the energy transition, it will fail.
Arguably, asking companies to set ambitious targets to decarbonise is the easy bit; this needs to result in actual meaningful emission reductions and we will continue to monitor progress. We called this initiative a challenge for a reason – it will not be easy to reduce emissions sufficiently within the remaining timeframe to avert the worst impacts of runaway climate change. But as proactive investors managing sustainable funds, we want to play our part by continuing to encourage a more rapid response to achieve this vital goal.
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